i nc lu s i ve f i nanc i ng
123
5.2 STRUCTURAL REORGANIZATION OF
THE BANKING SECTOR
Reorganization of the banking system has remained a
recurring theme in the financial liberalization debate in
India. It must be noted that along with proposing liberal
entry of private and foreign banks in the country, the
Narasimham Committee (1991) recommended restruc-
turing of public sector banks in India by reducing their
numbers significantly. It suggested that three to four big
banks including SBI should be developed as international
banks. Eight to ten banks having nationwide presence
should concentrate on the national and universal bank-
ing services, while region specific banking can be carried
out by local banks. It also recommended that the RRBs
should focus on agriculture and rural financing.
In the
Technical Paper on Differentiated Bank Licences
(2007) the RBI recognized the desire of certain banks to
follow a niche strategy to match the distinct risk profiles
of customers as also supervisory resources. However, it
also acknowledged the desirability of the system of full
service and universal banking given the low penetration
of banking services and the risks associated with any
liquidity crunch.
The Raghuram Rajan Committee (2009) in its report
proposed a two-pronged approach to restructuring
the banking system: (a) to facilitate the creation of
deposit taking small finance banks that are private
and voluntary institutions similar to LABs; and (b) to
strengthen the linkages between large and small financial
institutions. The higher risk of these banks can be offset
by their geographically focused operations, higher capital
adequacy norms, and strict monitoring and supervision
of transactions.
‘Localness’ and ‘smallness’ are the two chief attributes
of the small finance banks as proposed by the Raghuram
Rajan Committee—‘local’ in terms of the proximate
location of management and intimate knowledge local
financial needs and ‘small’ in terms of the flexibility and
ease of decision making by loan officers as also their low-
cost structure. These are ‘private’ or ‘voluntary’ banks in
that the management has a significant stake in the bank.
The large commercial banks in such an ecosystem would
be able to retail their financial products to small clients by
building linkages with small banks. The success of small
banks depends critically on flexibility and independence
to adopt low cost, innovative processes and structures,
including technological solutions.
Mention must be made here of the RBI discussion
paper,
Entry of New Banks in the Private Sector
(August
2010), which raised certain questions for deliberation by
the public and other stakeholders with respect to extend-
ing licenses to new banks. Granting of fresh licenses to
banks and thus expanding the number of competing
payers in the market, the paper argued, would eventu-
ally reduce costs, improve service quality of the overall
banking system, and promote financial inclusion and
inclusive growth. Notably, after reviewing the results of
the earlier rounds of licensing, the paper observed that
the country’s experience with small banks has not been
encouraging. Even the relatively well functioning LABs
suffer from growth constraints as the small bank model
has inherent inefficiencies—unviable and uncompetitive
cost structures (resulting from small size and concentra-
tion risk), dearth of competent staff and poor governance
standards. Other small banks like urban co-operative
banks and small deposit-taking NBFCs too, the paper
argued, were found to be facing problems such as low
capital base, lack of professional management, poor
credit management, and diversion of funds. The paper
invited comments and responses from the interested
stakeholders and larger public on issues like suitability
of issuing bank licenses to industrial houses and NBFCs,
desirable shareholding patterns, business models etc. The
wide range of comments received in response indicated
lack of consensus about the issues raised and reflected
the distinct sectoral positions held by banks, NBFCs
and industrial houses.
2
However, as per the final guide-
lines released in February 2013 private entities/groups,
public entities and NBFC promoters/promoter groups
were all made eligible to apply for banking licenses.
3
In
April 2014 ‘in-principle’ approval was granted to two
of the 25 applicants—IDFC Limited and Bandhan
Financial Services Private Limited—to set up banks
under the guidelines.
4
That some of the most ‘eligible’
entities—the India Post for instance—lost out in the final
selection surprised many (Box 5.1). The validity of the
‘in-principle’ approval is of 18 months. By September
2015 the grantees would have to fulfill all the require-
ments under the guidelines to be eligible to be issued a
regular license that will enable them to embark on their
banking business.
